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Oxford, Monday June 14, 2004
To mark the death of President Ronald Reagan earlier this month, Oxford Analytica is publishing a special analysis examining the economic legacy of this most influential of modern US presidents. This analysis is below.
We have also made available a selection of articles drawn from issues of The Oxford Analytica Daily Brief published during the Reagan presidency (1981-89). They focus on the key foreign policy issues that preoccupied the United States during Reagan’s eight years in the White House. This unique material is drawn from the almost 30 year-archive of daily global analysis that is available to clients of The Oxford Analytica Daily Brief.
Key Reagan-era articles from the Oxford Analytica archive.
SUBJECT: The economic legacy of President Ronald Reagan
SIGNIFICANCE: The Reagan era marked a watershed in many aspects of US economic policy. He presided over the largest peacetime fiscal deficits in the nation's history; made extensive use of import controls to restrain protectionist sentiment in the Congress during the dramatic dollar appreciation of the mid-1980s; and transformed labor relations by destroying a leading public sector union at the start of his term.
ANALYSIS: The fiscal legacy of the early Reagan years was large budget deficits resulting from his programme to cut tax rates and bolster defence spending. During his first term, the deficit rose from 2.6% of GDP to a peak of 6.0% in 1983. However, in contrast to the current administration of President George Bush, he was not oblivious to the risk of large fiscal deficits and accepted numerous tax rises after the large tax cut bill in 1981:
Tax revolution. In 1986, Reagan presided over the most far-reaching tax reform bill in modern US history. The bill slashed the top marginal tax rate on both wage and capital income to only 28% from 50% in return for curtailing many personal tax allowances. The bill survived until 1991, when President Bush senior boosted the top personal tax rate back to 31% in return for a larger package of spending cuts and tax increases. In 1993, the Clinton administration boosted the top marginal income tax rate all the way to 40%. As a result, the Reagan tax bill of 1986 marks the low point for US marginal income tax rates for the era since income tax rates were increased significantly during the Great Depression and the Second World War. The Bush junior tax legislation enacted last year has reduced the top marginal income tax rate back to 35% but this is still 7% higher than the Reagan tax bill of 1986.
Supply side lessons. The current Bush administration has been deeply influenced by the supply side legacy of the Reagan era. Both the president and his economic team have often denied that large fiscal deficits matter because of the experiences of the Reagan era. They believe that the economy will ultimately grow out of the deficits if they keep tax rates low and restrain spending. The great contrast with the Reagan era is that there has been much less restraint on spending:
Reagan's greatest legacy in reducing spending came after he left office. The collapse of the Soviet Union and the end of the Cold War set the stage for US defence spending to fall from nearly 6% of GDP to only 3% by the late 1990s. The large decline in defence outlays coupled with tax revenues from the economic boom of the late 1990s then set the stage for the federal fiscal surpluses which Reagan had hoped would occur during his term in office. The Clinton administration never embraced supply side economics and raised marginal income tax rates significantly, but it did enjoy a revenue windfall from the supply side miracle of robust productivity growth during the late 1990s.
Protectionism. The Reagan international economic policy was the most protectionist since the inter-war years. As the dollar rose sharply during the period 1982-1985, there was a large increase in protectionist pressure from the Congress. The Reagan administration attempted to contain these pressures by negotiating managed trade agreements for steel, semi conductors, machine tools, soft wood lumber, and textiles. These agreements ultimately encompassed nearly 22% of US foreign trade before plunging back to 10% in 1990. At an Institute for International Economics conference in 1984, White House Chief of Staff, James Baker, bragged that Reagan had imposed more import restraints than any president since Herbert Hoover.
Dollar devaluation. After Baker became Treasury Secretary, the Reagan administration also launched an initiative to devalue the dollar with the other G-7 countries at a summit conference in New York. During the next three years, the dollar declined by over 40% on a trade-weighted basis and encouraged a major revival of US exports. In fact, it was an export boom that helped to spur the recovery from the 1987 stock market crash.
Free trade. While the Reagan administration made extensive use of import barriers, it did attempt to promote global negotiations for more open markets. The GATT Tokyo Round had expired in 1979. In the mid-1980s, the administration helped to launch the Uruguay Round and followed up with a major trade bill in 1988 giving the President fast track trade negotiating authority. The Reagan administration also began the trend towards the U.S. negotiating bilateral trade agreements:
Both Regan trade ambassadors, Bill Brock and Clayton Yeutter, supported free trade but they were constrained by the legacy of the strong dollar during the administration's first five years.
Emerging market debt. The Reagan administration presided over the great developing country debt crisis that resulted from the severe monetary policy championed by Fed Chairman Paul Volcker and the collapse of commodity prices during 1981 - 1982. However, it did not play an active role promoting reduction of the debt burden, and Latin Americans therefore associate Reagan with a lost decade of economic stagnation. Reagan also gave the IMF a free hand to impose so-called structural adjustment policies in Africa and other developing regions.
Monetary policy. The Reagan administration had a complex but satisfactory relationship with the Federal Reserve. In the early days, Treasury Undersecretary, Beryl Sprinkel, often criticized the Fed for not controlling the growth of the money supply despite the fact that short term interest rates were at double digit levels. Despite the sparring with Sprinkel, the President reappointed Paul Volcker to a second term in 1983. He then appointed several supply-siders to the board who challenged Volcker's monetary policy and nearly promoted his resignation in 1986. However, in the end, they backed down, and Vice Chairman Preston Martin resigned instead.
In 1987, Reagan appointed Alan Greenspan as Fed Chairman:
The greatest financial problems of the Reagan era resulted from a poorly implemented deregulation of the banking and thrift sectors. The deregulation encouraged a dramatic upsurge of speculative lending for property and other sectors which culminated in widespread failures of both banks and thrifts. The cost of the thrift rescue exceeded 150 billion dollars.
Organised labour. The Reagan administration became hostile to the trade union movement shortly after taking office. The air traffic controllers launched a strike for large pay increases and the president rejected their demands. He ultimately broke the strike and destroyed the union. The spectacle of the administration destroying a seemingly powerful trade union had a dramatic impact on labour relations. It set the stage for more timid labour demands and a prolonged period of moderation in wage growth.
CONCLUSION: The economic policies of the Reagan administration had a major influence on economic policy in many countries. The spectacle of Ronald Reagan and UK Prime Minister Margaret Thatcher cutting taxes, privatising state-owned companies, and crushing powerful trade unions inspired conservative intellectuals all over the world. Political leaders in many countries tried to emulate the themes that were commonly associated with Reagan and Thatcher. As a result, Ronald Reagan managed to project US ideas and soft power more effectively than any other president of the modern era. He set an intellectual agenda that is still shaping public policy in the US and elsewhere.
